Commercial Mortgage-Backed Securities (CMBS) are bonds that derive their cash flows from principal and interest payments of commercial real estate loans. Despite current market weariness, there are still opportunities to invest in pools of well-performing loans with sustainable cash flow prospects. The initial screening process for CMBS deals involves property-level valuations considering factors like loan sponsorship, tenant composition, market dynamics, debt yield, and debt service coverage ratios. If a deal passes this screen, the bond structure is examined, with different classes or tranches offering varying levels of credit support to align with investors’ risk and return objectives.

CMBS remains a niche sector, making up about 3% of the $53 trillion bond market, which requires specific expertise and tends to have lower participation compared to traditional fixed-income sectors. Current negative headlines and bearish sentiment in the commercial real estate market may create buying opportunities, especially as spreads widen in mezzanine classes. The complexity of CMBS can lead to pricing inefficiencies, and with a deep understanding and disciplined underwriting process, these securities can provide superior risk-adjusted returns. Short-duration interest-only securities (IOs) within CMBS could be less sensitive to interest rate changes and offer better defense without significant credit risk compared to traditional bond sectors.